Trying to avoid geopolitical risk – so we bet on Mexico

Over the past month, a number of emerging market currencies have come under renewed pressure. This is particularly the case in central and eastern Europe (CEE). Renewed concerns over the geopolitical situation in Ukraine and, in particular, fear of an outright Russian invasion of Ukraine are adding to the worries in the markets.

However, it is not all bad. It should be noted that the recovery continued in the US, the UK economy is also doing better and there are clear signs that the Chinese economy is moving out of the ‘soft spot’. All this should be generally supportive for risk sentiment and the emerging markets in general. On the back of this, in our view, it is likely that the Latin American and emerging Asian markets in general will outperform the CEE markets – at least in the near term. This is clearly reflected in this month’s EM Bond Snapshot allocation.

Our allocation this month includes two major changes: South Africa moves from underweight to overweight, Mexico moves from neutral to overweight. We keep Russia on a significant underweight allocation, as we have for several months now.

Overweight: Mexico (+14.9%), South Africa (+11.1%)

Mexico should benefit from the continued US recovery and the Mexican economy should continue to recover. The risk sentiment towards emerging markets is also key for the Mexican markets. South Africa should benefit from the continued recovery of the US economy and also from China moving away from the ‘soft spot’.

Neutral: Hungary (+6.4%), Turkey (-3.9%)

Hungary moves to neutral. The geopolitical risks are clearly negative for Hungary, especially in the short term, but its fairly strong external position is likely to support the forint. Turkey remains in a neutral position this month, as the continued high inflation and large current deficit are likely to weigh on the lira. Overall, we see a gradual depreciation of the lira.

Underweight: Poland (-11.4%), Russia (-17.2%)

Poland moves to underweight. The zloty has been under significant pressure recently on the back of the re-escalation in the Ukrainian crisis and momentum clearly remains very negative. Furthermore, downside risks to growth and inflation have increased and that is likely to keep the zloty under pressure and to push Polish yields further down in the shortend of the curve. We keep Russia underweight this month, as we have for several months. The main risks continue to be geopolitical and global risk sentiment.